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Breaking up with your portfolio

Ending a relationship is hard. There’s a mixture of regret, anger as well as fear of never ever finding the right one. The more time, effort and resources invested, the harder it is to break free. So you are left to ponder what went wrong? What else could you have done besides a meticulous Internet search, word of mouth referrals, and a background check into your now maybe ex’s financials?

Initially, it all seemed perfect. Your love interest was consistent, stable, and provided small gifts at regular intervals. He/she had low debt and seemed to be on an accelerated path to success. As you immersed yourself further into the relationship, however, a few red flags began to appear. Your partner’s mood swings grew increasingly volatile, you overhead some people badmouthing him/her, and yes, there were some late payment notices. But since your partner vowed that these were merely temporary setbacks, you brushed it all aside.

The erratic behavior continued however and you were dragged into the downward spiral with your partner. The late payment notices piled up and became increasingly more urgent. The badmouthing became louder, more shrill, and harder to ignore just as like all bad news is. The gifts stopped of course and you were often left to pay your partner’s bills. All the potential you had imagined disappeared. So should you stay or should you bolt?

Realizing losses in your portfolio can often evoke similar emotions of regret, anger, and fear of further losses combined with inaction. Behavioral economists use the term loss aversion to characterize an investor’s strong preference of avoiding losses over accruing gains of the same magnitude. It’s even more difficult to let go when the investment had previously provided solid gains and consistent dividends. It’s also difficult to stay vigilant for risk factors when one is basking in profits but eventually the honeymoon period is replaced by a broken home of negative returns.

Sometimes, even if one does all the research, investments can tank due to unforeseen events. The subprime mortgage crisis obliterated banking legends such Lehman Brothers and Bear Stearns. Volkswagen’s share prices plummeted as the emission scandal unraveled. Shareholders of Tesco saw their investments tumble as the magnitude of its accounting scandal was exposed. The list goes on and on.

But though you may get blindsided at times, ignorance is not bliss. There is no real substitute for doing your own research. A healthy portfolio just like any healthy relationship requires time and effort. This includes keeping up to date with company’s financials, potential governmental regulations, reading analyst reports and latest news stories so you catch the badmouthing early, as well as conducting your own market research by checking for changing market trends. Using stop-losses is another tool many investors use to minimize losses. You can read about the pros and cons of the strategy here.

Finally, though it can be difficult to cut a stock out of one’s portfolio, the good news is that there are many strong companies out there and just like relationships, a failed attempt is usually not catastrophic and the wounds serve as learning experience.

Great observation. Many long-term investors focus on 3-5 year horizon, and for that time period, Tesco is down substantially. I do believe in Warren Buffet’s philosophy to hold winner stocks for as long as possible but again, I think there are exceptions to every rule. For owners of energy and commodity shares, holding on was probably akin to a bitter divorce as most investments lost close to 50% of value in the past year. However, stocks like Glencore have rallied this year so till the bitter end could prove to be a winner.

I love the ex-boyfriend metaphor. I am definitely on the side of doing your research, and not ignoring the signs of trouble (as we often do in relationships!). Whatever you choose to do, dropping the investment or sticking with it, being informed seems to give you more resources and options, not less. Especially after the fact, when you have to assess what went wrong? I think that’s a great way to learn
And- I’m personally the “cut your losses early” type
Anyway, great analogy and great post!